Auditor Industry Specialization, Auditor Changes, and Accounting Restatements

Abstract

SYNOPSIS: The increasing occurrence of accounting restatements has drawn considerable attention from regulators, audit firms, and corporate boards concerning audit and financial statement quality. Research suggests that auditor industry specialization is associated with improved error detection and greater financial statement quality. We examine the impact of auditor industry specialization on a sample of restatement and nonrestatement firms and find that auditor industry specialization is negatively associated with the likelihood of accounting restatement. In addition, focusing on the subset of restatement firms, we find that auditor industry specialization reduces the likelihood of issuing restatements affecting core operating accounts, suggesting that industry specialization adds value in auditing a particularly critical area of the firms’ continuing operations. Finally, we find changing from a nonspecialist to a specialist auditor increases the likelihood of restatement, and changing from a specialist to a nonspecialist reduces the likelihood of restatement. Our findings are consistent with industry specialization enhancing auditors’ role in improving the quality of the financial reporting process, particularly related to the core operations of their clients.